There's a big problem with the last tool in the arsenal of the world's central banks

Once thought to be a fringe possibility as an economic tool,
policies of negative interest rates are quickly becoming more
common around the world.

Denmark's Nationalbank introduced negative rates in July 2012. It
has been followed by the likes of the European Central Bank, the
Swiss National Bank, Sweden's Riksbank, and, most recently, the
Bank of Japan.

In principle, the decision to adopt negative-interest-rate
policies, or NIRP as it has become affectionately referred to by
markets, is an understandable approach to help boost economic
activity.

Discouraging upward pressure on their currencies through
increased interest-rate differentials, along with encouraging new
lending to the private sector by penalising banks that chose to
place excess deposits with them, should help trade-exposed and
domestic sectors when NIRP is adopted.

Or so the theory goes.

That hasn't fully played out in reality. As the excellent chart
from Bank of America-Merrill Lynch reveals below, in the month
after the adoption of NIRP, currency weakness, increased
inflation expectations, and gains in stock markets have, by and
large, not eventuated.

In most instances the opposite has actually occurred.

BofA

According to Chris Xiao and Vadim Iaralov, foreign-exchange
strategists at BAML, even though previous unconventional monetary
policy such as quantitative easing helped to weaken currencies,
boost asset prices, and firm up inflation expectations, there may
be a simple reason that NIRP is not delivering the same result:
The markets are exhausted by stimulus, and as a consequence it's
losing its potency.

As the chart below shows, when it comes to delivering positive
policy outcomes, quantitative-easing programs were far more
successful thanNIRP regimes in terms
of currency devaluation, asset-price growth, and firmer inflation
expectations.

BofA

"In our view, the ineffectiveness of NIRP could be due to the
market interpreting it as policy exhaustion as markets require
ever-increasing accommodation to achieve the same outcome," Xiao
and Iaralov said.

With monetary stimulus seemingly less potent that what it once
was, and global growth still fragile at best, Xiao and Iaralov
suggest that the risks for a more adverse market shock, referred
to by BAML a tail risk, are building.

"If the effectiveness of central bank stimulus continues to
decline, the probability of further policy exhaustion will
continue to increase, and hedging tail risks becomes more
attractive. Some potential scenarios are US deflation or major
declines in global financial assets as implicit global central
bank puts disappear."

Given the huge gains in asset prices seen in the years after the
global financial crisis, largely fueled by an unprecedented wave
of monetary-policy stimulus, should investors lose faith that
increasingly innovative central-bank policy can help improve
underlying economic conditions, there's very little — including
fiscal policy — for markets to fall back on.